Thursday, October 22, 2009

What insurance really is.

It seems a lot of people have trouble understanding insurance. However, I'm pretty sure everyone understands the concept of a bet, and that's all insurance really is. You say to the insurance company, "I bet that I will need money to repair my car after an accident". The car insurance company looks at your driving record, and at the records of other drivers similar to you, and at their books, and says "I will take your bet. Your stake is [the amount of your premium], and we don't think you'll need a payout." Naturally, sometimes they're wrong. This is why they take thousands of such bets; on almost all of them, they're right. The income from the stakes they get to keep pays for the smaller number of times they're wrong, and if they guess right, they wind up with a profit overall.

That's an example using car insurance. There are specialised car insurers who work with classic cars, which don't fit into the normal car insurer's accounting procedures well; they can still make profits, because the owners of classic cars are careful with them. They don't make '64 Corvettes any more, so you're not going to treat your '64 Corvette with disdain. You'll garage it, you'll keep it clean, not drive it in the rain, and lavish care on it, because it's effectively irreplaceable. Meanwhile, your Corolla that you get the groceries in is a commodity; there's always another Japanese econobox.

Today, I saw somebody advocating, for health insurance reform, simply removing the ability of health insurers to deny coverage based on pre-existing conditions. While this would possibly improve matters for victims of rape and domestic violence, it's not a solution. Since insurance is a bet, taking on someone that you can know for a fact will need to make claims makes you a sucker. I've even seen suggestions that new insurance companies will arise to offer coverage to those with pre-existing conditions, like the car insurance companies which cater to classic cars.